What Would Keynes Say Now?

In the latest edition of the magazine, I have a longish essay on John Maynard Keynes, whose magnum opus, “The General Theory of Employment, Interest, and Money,” turns seventy-five this year, and who is the subject of several new books. (For the moment, the piece is behind a firewall.) Obviously, it’s not exactly an unexplored subject, but Keynes is one of those pesky fellows who simply won’t go away, despite the best efforts of Rick Perry and many other conservatives to consign him to history.

As somebody who was first taught economics in England, and who has written a lot about market failures, I have always thought of myself as a “Keynesian.” But the task of rereading much of Keynes’s writings and distilling them into five thousand words accessible to the general reader forced me to think hard about what the phrase really means, both in terms of economic theory and current policy applications. Keynes wrote a lot, and over the years his views changed quite substantially. If you search his writings, you can find a quote here or there to back up all sorts of things, including even supply-side economics. (Thanks to Dr. Arthur Laffer for pointing out that one.) But the real essence of Keynes, I eventually decided, can be expressed in these terms:

In the short-run, demand is what drives economies, not prices.

In a demand-driven economy, many types of unfavorable and self-sustaining outcomes are possible, including lengthy slumps.

The role of the government is to sustain demand and help the economy avoid such disastrous outcomes.

I regard these statements as truisms, even though others would dispute them, to varying degrees. Once you get beyond them, things get murky. For example, like most economists of a certain age, I was brought up on the “I.S.L.M.” model, a toy version of Keynesianism due to Sir John Hicks, which allows you to depict the entire economy in the form of two simple curves: one representing investment and saving, the other the supply and demand for money. In policy terms, the I.S.L.M. setup remains immensely useful. Whenever I hear somebody saying, “We should cut taxes on X,” or, “The Fed should do Y,” I automatically think to myself: “What would that do to the I.S. and L.M. curves?” I’d be willing to bet that many of the economists who work at the White House and the Fed go through a similar exercise.

But I.S.L.M. is a crude form of Keynesianism. It depends on the assumption that prices are fixed, which is obviously not true. Conservative economists have always posed this question: In a depressed economy, why won’t prices and wages adjust to restore a full-employment “equilibrium”? Keynes’s answer, which it must be said he never fully integrated into what modern economists would recognize as a “model,” had to do with uncertainty and crowd psychology. When “animal spirits” are depressed, he pointed out, the mere availability of cheap money and cheap labor won’t be sufficient to make businesses invest and expand. Rather, the economy will get stuck in rut.

There’s much more about this is in the piece, together with some speculations about what Keynes would be recommending now. Obviously (at least I think it’s obvious) he would be defending the Obama stimulus and arguing for more of the same. But I think he would also be consumed by the international situation, particularly the European debt crisis. After his experience at the Paris peace talks after the First World War, where he saw the victors impose onerous debts on the Germans and Austrians with disastrous consequences, he would surely be pushing for a restructuring of Greek debt, and probably something similar for Ireland and Portugal, too.

Finally, and I didn’t put this in the piece, I think Keynes would be sympathetic towards the anti-Wall Street protestors who are camping out in downtown Manhattan. Somewhat like George Soros, Keynes was an ardent and skilled speculator in the markets who, nonetheless, had few illusions about the social utility of various fashionable forms of finance. “Speculators may do no harms as bubbles on a steady stream of enterprise,” he wrote. “But the position is serious when enterprise becomes a bubble on the whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, it is likely to be ill-done.”